Fitch may downgrade Citigroup; cuts Wachovia

Fitch has an "AA-" long-term issuer default rating on Citigroup.

Separately, Fitch downgraded Wachovia's long-term IDR to junk status, or to "BB-" from "A+."

While Fitch views the acquisition as a positive for Citigroup, in terms of it substantially increasing its retail banking franchise, the ratings service remains concerned by the bank's asset quality problems.

Fitch expects Citigroup to post a loss in the third quarter. If losses and asset quality problems continue in future quarters, Fitch may downgrade the bank's ratings, though likely not below the "A+" level, Fitch said.

"The strategic benefits of Citigroup Inc.'s acquisition of Wachovia Corp.'s retail, corporate/investment and private banking operations are tempered by Citi's own escalating asset quality challenges," Fitch said.

The deal, arranged by federal regulators on Monday, greatly expands Citigroup's retail franchise--giving it a total of more than 4,300 U.S. branches and $600 billion in deposits--and secures its place among the U.S. banking industry's Big Three, along with Bank of America Corp. and JPMorgan Chase & Co.

However, Citigroup slashed its quarterly dividend in half to 16 cents and announced plans to sell $10 billion in common stock to shore up its capital position.

In addition to assuming $53 billion worth of debt, Citigroup will absorb up to $42 billion of losses from Wachovia's $312 billion loan portfolio, with the Federal Deposit Insurance Corp. agreeing to cover remaining losses, if any. Citigroup also will issue $12 billion in preferred stock and warrants to the FDIC.

The remaining Wachovia Corp. will consist of its asset management, retail brokerage and certain select parts of its wealth management businesses, including the Evergreen and Wachovia Securities franchises. It will continue to be a public company under the Wachovia name.